Final Report Summary - MERGERMICROSTRUCTURE (Microstructure of takeover markets)
This project aims to contribute to the financial Mergers and Acquisitions literature by examining the microstructure of takeover markets. 'Microstructure of takeover markets', a broad definition for the conduct and the process of corporate takeovers, aims to investigate the impact of micro-level factors on merger outcomes. Do target firm shareholders receive higher premiums from hostile bidders? Does acquiring a small stake in the target firm before making the main offer (toehold strategy) work better for the bidder? Are target firms more likely to be sold as their CEOs get closer to their retirement ages? The microstructure of takeover markets aim to answer questions of this nature.
The primary tool used in this project for examining the merger process is the concept of deal initiation. Recent research shows that there is a significant difference between bidder- and target-initiated deals. In bidder-initiated deals, bidders contact target firms and propose takeovers even though target firm managers and shareholders have no prior intentions of selling their firms. In target-initiated deals, target firm managers and shareholders decide to put their firms up for sale, and contact potential buyers for that purpose.
The first objective of this project is to analyze the relationship between deal initiation and competition in mergers. We aim to answer the following questions: How does the number of bidders competing to acquire targets differ in bidder-initiated and in target-initiated deals? Do bidders prevent outside competition by offering high premiums to target firms? The second objective is to analyze managerial incentives during the merger process. Merging firm CEOs receive compensation when mergers consummate, which might lead them get involved in deals that are value decreasing from shareholders' perspective but income generating from their perspectives. We aim to answer the following questions: Do target firm managers initiate deals and sell their firms in order to maximize their own benefits? How does CEO compensation, such as golden parachutes, bonus payments, stock option grants differ across initiation groups? The third objective is to analyze the relationship between earnings management and deal initiation. Recent research shows that acquirers engage in earnings management practices, especially in stock-for-stock mergers. We aim to answer the following questions: Is earnings management by target firms more prevalent in target-initiated deals? Do acquirers manage earnings first, so that the financials of their firms look much stronger, and then initiate deals?
The project involves creating a customized dataset, as conventional M&A databases do not record which party initiated the deal or how many bidders competed to acquire the target. This information is collected from in the SEC documents submitted by the merging firms right before shareholders' approval for the takeover. Initiation and competition data are gathered for a sample of 831 deals from these documents. To perform univariate and multivariate analysis, stock price and accounting information of the merging firms are gathered from the CRSP and Compustat databases and managerial compensation and CEO retention data are gathered from the proxy statements of the target firms and the news sources available in the Lexis-Nexis database.
The first part of the project, which aims to investigate the relation between deal initiation and the level of competition in mergers, uncovers several interesting facts. First, targets choose 'auctions' (the number of bidders competing to acquire the target is greater than one) more often when they initiate deals. 67% of target-initiated deals are classified as auctions and the remaining 33% as 'negotiations' (the number of bidders competing to acquire the target is one). On the other hand, 53% of the bidder-initiated deals are auctions and the remaining 47% are negotiations. Second, the target firms in the target-initiated group behave as if they are more desperate to find a bidder, contacting an average of 14.9 bidders, sign confidentiality agreements with 5.7 of them, and receive bids from 1.5 of them during the takeover process. If the targets in the bidder-initiated group decide to contact other bidders, they contact only 7.7 bidders, sign confidentiality agreements with 3.2 of them and receive bids from 1.43 of them. This evidence is consistent with the argument that the target firms in the bidder-initiated group are less concerned about drawing a larger number of bidders into the process. Third, when a bidder initiates a deal with the target, and the target decides to contact other bidders (in an auction), there is almost an even chance that the original bidder will end up acquiring the target. In 58% of the bidder-initiated and auction deals, the original bidder who initiates the takeover process acquires the target. In 42% of such deals, the target is acquired by another bidder. Because the high level of competition increases the risk that the target is lost to another party, bidders have strong incentives to limit outside competition.
The second part of the project aims to examine whether the personal benefits of target managers influence the deal initiation and the choice of sale decisions of target firms. The target CEOs receives compensation of different forms during the merger process, such as appreciation of their stock and options holdings, golden parachutes and additional bonuses. The empirical evidence indicates that the monetary benefits of the target CEOs in the form of stock and options appreciation is higher in bidder-initiated deals than in target-initiated deals. However, merger-induced cash payments in the form of golden parachutes or additional bonuses do not differ across deal initiation groups. The final form of the personal benefits received by the target CEOs is their retention by acquirers in the post-merger period. The empirical evidence does not support the claim that the target CEOs negotiate their retentions with the acquirers in bidder-initiated deals, as the retention rate is very similar in bidder- and target-initiated deals.
The third part of the project analyzes the link between the earnings management practices of the target firms and their deal initiation decisions. It is conceivable that the target firm managers manage their earnings before putting up their firms up for sale, so that their firm looks more attractive to the potential bidders. If this conjecture is true, there would be an empirical association between the earnings management proxies and the deal initiation status. The empirical findings do not indicate such an opportunistic behavior by target firms: the average target firm discretionary accruals (before the merger announcements) in the target-initiated group are statistically indistinguishable from that of the bidder-initiated group.
The findings of this project are important for several reasons. The global corporate M&A activity reached 2.7 trillion USD in volume by the end of 2012. This enormous transaction volume is an important factor for researchers' increased interest in investigating the mechanics of corporate takeovers. Mergers and acquisitions are giant corporate events that deeply affect the respective industries and the economy; therefore, understanding the micro foundations of these markets, as well as their workings and the incentives of the merging parties, are crucial for rendering the appropriate legal frameworks that define the conduct of business. For instance, uncovering managerial incentives during the merger process could help corporations and government agencies design more efficient contracts that align managers' interests with that of shareholders. If some mergers are consummated to the end of managerial perks and benefits, rather than stakeholders' interests, then managerial incentives should be altered by appropriate contracts and laws so that they coincide with the stakeholders' objectives. Also, the identification of firms that are involved in earnings management could help relevant players accurately value and appraise the merging firms.
The primary tool used in this project for examining the merger process is the concept of deal initiation. Recent research shows that there is a significant difference between bidder- and target-initiated deals. In bidder-initiated deals, bidders contact target firms and propose takeovers even though target firm managers and shareholders have no prior intentions of selling their firms. In target-initiated deals, target firm managers and shareholders decide to put their firms up for sale, and contact potential buyers for that purpose.
The first objective of this project is to analyze the relationship between deal initiation and competition in mergers. We aim to answer the following questions: How does the number of bidders competing to acquire targets differ in bidder-initiated and in target-initiated deals? Do bidders prevent outside competition by offering high premiums to target firms? The second objective is to analyze managerial incentives during the merger process. Merging firm CEOs receive compensation when mergers consummate, which might lead them get involved in deals that are value decreasing from shareholders' perspective but income generating from their perspectives. We aim to answer the following questions: Do target firm managers initiate deals and sell their firms in order to maximize their own benefits? How does CEO compensation, such as golden parachutes, bonus payments, stock option grants differ across initiation groups? The third objective is to analyze the relationship between earnings management and deal initiation. Recent research shows that acquirers engage in earnings management practices, especially in stock-for-stock mergers. We aim to answer the following questions: Is earnings management by target firms more prevalent in target-initiated deals? Do acquirers manage earnings first, so that the financials of their firms look much stronger, and then initiate deals?
The project involves creating a customized dataset, as conventional M&A databases do not record which party initiated the deal or how many bidders competed to acquire the target. This information is collected from in the SEC documents submitted by the merging firms right before shareholders' approval for the takeover. Initiation and competition data are gathered for a sample of 831 deals from these documents. To perform univariate and multivariate analysis, stock price and accounting information of the merging firms are gathered from the CRSP and Compustat databases and managerial compensation and CEO retention data are gathered from the proxy statements of the target firms and the news sources available in the Lexis-Nexis database.
The first part of the project, which aims to investigate the relation between deal initiation and the level of competition in mergers, uncovers several interesting facts. First, targets choose 'auctions' (the number of bidders competing to acquire the target is greater than one) more often when they initiate deals. 67% of target-initiated deals are classified as auctions and the remaining 33% as 'negotiations' (the number of bidders competing to acquire the target is one). On the other hand, 53% of the bidder-initiated deals are auctions and the remaining 47% are negotiations. Second, the target firms in the target-initiated group behave as if they are more desperate to find a bidder, contacting an average of 14.9 bidders, sign confidentiality agreements with 5.7 of them, and receive bids from 1.5 of them during the takeover process. If the targets in the bidder-initiated group decide to contact other bidders, they contact only 7.7 bidders, sign confidentiality agreements with 3.2 of them and receive bids from 1.43 of them. This evidence is consistent with the argument that the target firms in the bidder-initiated group are less concerned about drawing a larger number of bidders into the process. Third, when a bidder initiates a deal with the target, and the target decides to contact other bidders (in an auction), there is almost an even chance that the original bidder will end up acquiring the target. In 58% of the bidder-initiated and auction deals, the original bidder who initiates the takeover process acquires the target. In 42% of such deals, the target is acquired by another bidder. Because the high level of competition increases the risk that the target is lost to another party, bidders have strong incentives to limit outside competition.
The second part of the project aims to examine whether the personal benefits of target managers influence the deal initiation and the choice of sale decisions of target firms. The target CEOs receives compensation of different forms during the merger process, such as appreciation of their stock and options holdings, golden parachutes and additional bonuses. The empirical evidence indicates that the monetary benefits of the target CEOs in the form of stock and options appreciation is higher in bidder-initiated deals than in target-initiated deals. However, merger-induced cash payments in the form of golden parachutes or additional bonuses do not differ across deal initiation groups. The final form of the personal benefits received by the target CEOs is their retention by acquirers in the post-merger period. The empirical evidence does not support the claim that the target CEOs negotiate their retentions with the acquirers in bidder-initiated deals, as the retention rate is very similar in bidder- and target-initiated deals.
The third part of the project analyzes the link between the earnings management practices of the target firms and their deal initiation decisions. It is conceivable that the target firm managers manage their earnings before putting up their firms up for sale, so that their firm looks more attractive to the potential bidders. If this conjecture is true, there would be an empirical association between the earnings management proxies and the deal initiation status. The empirical findings do not indicate such an opportunistic behavior by target firms: the average target firm discretionary accruals (before the merger announcements) in the target-initiated group are statistically indistinguishable from that of the bidder-initiated group.
The findings of this project are important for several reasons. The global corporate M&A activity reached 2.7 trillion USD in volume by the end of 2012. This enormous transaction volume is an important factor for researchers' increased interest in investigating the mechanics of corporate takeovers. Mergers and acquisitions are giant corporate events that deeply affect the respective industries and the economy; therefore, understanding the micro foundations of these markets, as well as their workings and the incentives of the merging parties, are crucial for rendering the appropriate legal frameworks that define the conduct of business. For instance, uncovering managerial incentives during the merger process could help corporations and government agencies design more efficient contracts that align managers' interests with that of shareholders. If some mergers are consummated to the end of managerial perks and benefits, rather than stakeholders' interests, then managerial incentives should be altered by appropriate contracts and laws so that they coincide with the stakeholders' objectives. Also, the identification of firms that are involved in earnings management could help relevant players accurately value and appraise the merging firms.